NEW DELHI, July 8 (Reuters) - Indian Prime Minister Narendra Modi’s government disappointed markets with its first major economic policy statement on Tuesday, promising to seek foreign and private funding for the railways but giving no details of how it would lure investors.

Investors had harboured expectations for Modi’s government to use the railways budget - which precedes the full federal budget by two days - to detail widespread reform.

India’s state-owned railways are the fourth-largest in the world. They have suffered from years of low investment and populist policies that have kept fares low.

But that has turned a once-mighty system into a slow, badly-congested network that crimps economic growth.

The railways cost the government around 300 billion rupees ($5 billion) a year in subsidies and spend 94 percent of revenues on operating costs, leaving next to nothing for investment.

The budget contained some minor measures, such as a greater use of “mechanized laundries” to eliminate the washing by hand still employed to clean much of the bedding on sleeper trains.

But it was short on details of how the wider goals would be met and how Gowda would get foreign companies such as Bombardier and General Electric to invest.

Indian stocks fell sharply following Gowda’s speech, with the benchmark index closing down 2 percent after the government dashed investors’ hopes for greater spending on the railways, while bond yields rose.

The government revised up planned spending to 654.45 billion Indian rupees for the year ending in March 2015, an increase of 1.8 percent from an interim budget prepared in February by the last government.

It calculates investment in the network through public-private partnerships in 2014/15 to total 60.05 billion rupees, more than in the interim budget, but a fraction of the cash needed to overhaul the network.

RELIC OF BRITISH RULE

India’s use of a railway budget separate from the national one is a relic of British rule, when the network was the country’s major industrial asset and a major revenue earner. Finance Minister Arun Jaitley presents the full federal budget on Thursday.

“There is nothing in this entire budget which tells you how they will make it attractive for private sector,” said Manish R. Sharma, executive director of capital projects and infrastructure at PwC India.

“Given that in the past PPP has not taken off in railways...it would be very important to see how they come up with implementable mechanisms which the private sector will buy,” he said.

Gowda said proposed market borrowings would total 117.9 billion rupees this fiscal year, down from 128 billion rupees estimated in the interim budget.

“Budgeted outlay is looking below expectations as the government is looking for more private partnerships now than on previous occasions,” said Deven Choksey, managing director at KR Choksey securities.

Reform of India’s railways has long proven politically sensitive. Successive governments have backed away from modernization, preferring instead to use the system to provide cheap transport for voters, and jobs for 1.3 million people.

That sensitivity was on display on Tuesday, when supporters of India’s main opposition party gathered outside Gowda’s residence to protest against a recent fare rise, and one protester removed the minister’s nameplate from his gate, local TV showed.

Modi’s government pushed through a fare rise last month, but partially rolled it back later, under political pressure. ($1=59.7400 Indian Rupees) (Additional reporting by Malini Menon, Manoj Kumar, Aditya Kalra, Suvashree Dey Choudhury and Abhishek Vishnoi; Editing by Frank Jack Daniel and Richard Borsuk)